Q1 2020 Earnings Call

Okay. Thanks, I'm play from you know.

Good day, everyone and welcome to the Mercury systems first quarter fiscal 2020 conference call. Today's call is being recorded at this time for opening remarks, and introductions I'd like to turn the call over to the company's executive Vice President and Chief Financial Officer, Mike <unk>. Please go ahead Sir.

Good afternoon, and thank you for joining US with me today is our president and Chief Executive Officer, Mark Aslett.

If you've not received a copy of the earnings press release, we issued earlier. This afternoon, you can find it on our website at MRC wide dot com.

The slide presentation that Mark and I will be referring to is posted on the investor Relations section of the website under events and presentations.

Please turn to slide two in the presentation.

Before we get started I would like to remind you that today's presentation includes forward looking statements, including information regarding Mercury's financial outlook future plans objectives business prospects and anticipated financial performance.

These forward looking statements are subject to future risks and uncertainties that could cause our actual results or performance to differ materially.

All forward looking statements should be considered in conjunction with the cautionary statements on slide two in the earnings press release and the risk factors included and Mercury's FCC filings I.

I'd also like dimension that in addition to reporting financial results in accordance with generally accepted accounting principles or gap during our call. We will also discuss several non-GAAP financial measures specifically adjusted income adjusted earnings per share adjusted EBITDA free cash flow organic revenue at acquired revenue.

A reconciliation of these non-GAAP metrics is included as an appendix is a slide presentation and in the earnings press release on.

I'll now turn the call over to Mercury's, President and CEO Mark Aslett, Please turn to slide three.

Thanks, Mike Good afternoon, everyone and thanks for joining us I'll begin with the business update Mike will review the financials and guidance and then we'll open it up your questions.

But we delivered strong results for the first quarter fiscal 20, extending the momentum from fiscal 19 with record revenue backlog in that Didnt call.

The industry environment as positive not business model is performing extremely well.

We continue to execute strategically by investing in all people technologies and capabilities growing organically and supplementing organic growth with strategic M&A.

Given the strong start to the year, we're raising our fiscal 20 revenue guidance. In addition, we now expect to deliver 11% to 12% organic growth for the.

Turning to our Q1 financial highlights on slide full our revenues are growing faster than the industry average total revenue for the first quarter increased 23% from Q1 fiscal 19 exceeding the high end about guidance organic revenue was up 17% compared with 6% growth in Q.

One last year.

Our largest revenue programs in the quarter. We're a next generation missile system SEAWIP Filthy buzzard Pizzuti Hawkeye NCPS.

Q1 was another very strong quarter for new business total bookings were up 21% year over year to $216 million, leading to a record backlog in the book to bill of more than 1.2.

Our largest bookings programs in the quarter, where PG K filthy buzzard P eight patriot and filthy Badger.

But we also delivered strong levels of profitability.

Adjusted EBITDA was up 16% from Q1 last year exceeding the high end about guidance.

As expected free cash flow came in at 40% of adjusted EBITDA, reflecting year and bonus payments as well as our acquisition integration and growth investments.

Turning to slide five for an operational perspective, we're making great progress integrating prior acquisitions and investing in the business with future organic growth.

Over the past several years, we've built out our road domestic manufacturing capabilities, we're now making progress on a multiyear journey to improve both working capital efficiencies on the manufacturing operations themselves.

This quarter, we expect to complete the build out of our West coast RF plant and facility consolidation plan.

That point, we'll have created state of the art RF manufacturing facilities on both the east and west coasts.

In addition, as we announced on October 15th we're investing $15 million to expand the scope of off trusted microelectronics business in Phoenix.

The build out of the new clean room is underway and ordering capital equipment.

As background, we acquired this microelectronics business from Microsemi in Two Q2 016.

It's performed extremely well under book reason to ship since that more than doubling in revenue with improved profitability.

Our goal for this next round of investment is to take the business in Phoenix to the next level. We're positioning Mercury is a leading merchant supplier for commercially developed custom silicon to the defense industry.

The DFT needs access to commercial silicon technology, given the dynamics of R&D funding and where innovation is occurring.

We believe mercury is uniquely positioned to meet this need.

As a high Tech company that operates in defense, we have proven expertise in complex systems design embedded security silicon integration and trusted manufacturing.

Our new capabilities in Phoenix will allow us to deliver a next generation heterogeneous silicon open architectures and military grade computing, a chip scale using the most advanced commercially available technologies.

These technologies will enable new applications in rate, all VW missile systems, and communications as well as AI and autonomy.

We believe this is an opportunity with significant innovation organic growth potential for mercury over the mid to longer term as well. It has the potential to provide our defense prime customers on the DMT with much needed trusted microelectronics innovation.

We're very pleased to hop Tom small could join our team is VP and general manager to lead. This initiative Tome Briggs two decades of experience developing semiconductor technologies for embedded defense computing in system security.

In addition, as we announced on September 25th Bill Coli is joins Mercury's Chief Technology Officer after serving as the director for electronic warfare at the DMT for the past four years.

Bill is widely known in the industry in universally respected this decision to end the private sector as part of Mercury is a testament to our unique position at the intersection of commercial innovations that masa on the government's top defense priorities.

We're also continues to make solid progress integrating mercury's previous acquisitions Tennyson germane to now fully integrated the Athena instead tonic business systems integration are essentially complete.

Where the final phase of integrating gecko avionics, which should be complete this quarter.

And we are underway on the integration of APC, which closed on September 23rd.

The APC team brings is highly differentiated capabilities in support of our strategy to build out an industry, leading avionics processing and mission computing business.

The team is very excited to be part of Mercury and we're already seeing new opportunities as a result of the acquisition.

Turning to slide six the defense funding and industry growth environment remains favorable the two year defense budget deal provides funding through government fiscal 21.

We're currently operating under a CR, which goes through November the 21st we're cautious however that the currency all could be extended further.

Defense spending is trending higher, especially the investment accounts. The DMD is prioritizing the rapid modernization and next generation technologies and capabilities, which aligns well with our strategy.

The level of new programs soften design win activities remains elevated we're seeing substantial growth from the estimated lifetime value about top 30 programs and pursuits. This growth has been driven by three industry trends that we've discussed in the past.

These and trends include first supply chain delevering by the government and the primes second the flight to quality supply is by the primes onto most important increase outsourcing by our customers at the subsystem level.

We continue to see outsourcing as the largest secular growth opportunity in defense.

Market activity related to modernization in rate, all VW and supply remains very high.

We're seeing new opportunities in weapons systems space avionics processing and mission computing as well as secure an embedded rugged service.

For example, during the first quarter, we want to new designed to provide secure rugged service on a classified program.

Whose lifetime value, we currently estimate at $300 million.

We were notified that we won a processor upgrade on the Apache attack helicopter avionics and mission computing business. In addition, Raytheon recently announced the one l. Toms the Patriot missile defense system replacement, which is a major wins for Mercury.

The theme underpinning. These activities is the shift towards safe secure and trusted processing architectures, we believe that more of the technology that goes into our military platforms will need to be designs and produce in the us as a result, we've been making significant investments to develop and manufacture secure hardware and.

Software capabilities domestically.

Our customers the supplementing Mercury's high level of internally funded R&D with R&D of their own.

Given the substantial combined investment we've been able to rapidly adopt dock commercially available technologies to new and emerging defense opportunities.

Both our target markets are growing faster than defense market overall settlement effect. The revenue accounted for 57% of total revenue in Q1, increasing 29% from Q1 last year.

See fly revenue increased 11% year over year to 28% of Mercury's total revenue.

Turning to slide seven and looking forward, we're positive about our business outlook, we're seeing very high levels of new design win activity and opportunities for continued growth.

Over the longer term of based Fourq baseline forecast is for overall defense spending to increase at low single digit rates.

Our goal is to deliver organic revenue growth at a rate that exceeds this industry average.

We're also well positioned to supplement our high levels of organic growth with M&A, we continue to be successful acquiring on rapidly integrating businesses that fit well with mercury.

The M&A pipeline is robust and we're seeing interesting opportunities of varying sizes that the consistent with our strategy.

We intend to remain active on disciplines in our approach to M&A focusing on the sensor and effective mission systems on the fly markets as we have in the past.

We're looking for deals this strategically aligned and have the potential to be accretive both in the short and long term.

The combination of strong margins and organic revenue growth supplemented with disciplined M&A and full integration forms the core vast strategy.

We believe this strategy will continue to generate significant value for shareholders over the longer term as we execute our plans in five areas.

First is to drive on average double digit organic revenue growth supplemented by acquisitions. This is consistent with the 26% compound annual growth in total company revenue we've delivered over the last five fiscal years.

The second is to invest in new technologies, our facilities manufacturing assets and business systems. We will also invest heavily in our people.

Third as manufacturing insourcing as well as driving strong operating performance across our manufacturing locations. The goal here is to enhance margins quality and on time delivery, while improving working capital efficiencies over time.

Fourth we are seeking to grow revenues fast as an operating expenses.

This will allow us to continue investing in organic growth, while maintaining strong operating leverage in the business.

And finally, we're fully integrating the businesses, we acquired to generate cost on revenue synergies over time.

The synergies combined with other areas as the plan should produce attractive returns for our shareholders.

So in summary, we remain focused on executing the strategy I just outlined its been successful for us over the past five years, and we look forward to extending this record of success.

Our organic growth is accelerating and expanding our trusted microelectronics business should add to this momentum over the longer term.

We're bullish about the M&A pipeline, our manufacturing initiatives is delivering results and our acquisition integrations are progressing well.

Driven by these positive dynamics run anticipating another year of double digit growth in revenue and adjusted EBITDAR in fiscal 20, now, including 11% to 12% organic revenue growth.

Mike will take you through the guidance in detail and so with that I'd like to turn the call over to Mike Mike.

Thank you Mark and good afternoon again, everyone.

Mercury started fiscal 2000 with strong first quarter results total revenue adjusted EBITDA and adjusted EPS were up from Q1 last year, we delivered solid bookings growth and concluded the quarter with record backlog.

Mercury's revenue outperformance gives us the flexibility to continue making growth investments in the business, while still exceeding our expectations for adjusted EBITDA.

In addition to delivering strong financial results in Q1, we completed the acquisition of American Panel Corporation, which we funded with cash on hand.

We remain active on the M&A front and as Mark said, our pipeline remains robust our acquisition integrations remain on track and we're continuing to realize the forecasted cost and revenue synergies.

Given mercury strong performance in Q1, we're increasing our full year fiscal 2000 guidance for revenue adjusted EBITDA and adjusted EPS. This guidance includes approximately 2 million of operating expenses related to the custom micro electronics initiative in Phoenix that Mark discussed.

For the remainder of the year, we expect to continue investing in the growth of the business, while still delivering record results.

Turning now to the metrics on slide eight Mercury's revenue and bookings growth continued to translate into solid profitability in Q1.

Total bookings increased 21% year over year, driving a 1.22 book to Bill ratio.

We ended the quarter with record backlog of $711.8 million, an increase of 40% compared to Q1 fiscal 19.

Backlog expected to ship within the next 12 months increased 32% from Q1 last year to 499.2 million.

Total revenue increased 23% from Q1 last year to 177.3 million exceeding our guidance of 160 to 170 million.

Organic revenue was up 17% year over year and as Mark said, we now expect 11 and 12% organic growth for the year.

Gross margin for Q1 was 44.2% above our guidance of 43.5% and above 42.8% in Q1 of fiscal 19.

Gross margin was up year over year, primarily due to program and product mix and an inventory step up associated with the acquisition of Germain in Q1 fiscal 19 gross.

Gross margins in Q1 20 also benefited from planned cost synergies associated with the acquisition integration of tennis and Jermaine.

In Q1, internal R&D was 21.9 million compared to 14.9 million in Q1 of fiscal 19.

As a percentage of sales R&D was 12.3% compared to 10.4% a year ago and 11.5% last quarter.

This increase is primarily driven by our increased investment and secure processing products to support recent design wins.

SG in a for Q1 was $30 million, an increase of 21.1% from 24.7 million in Q1 last year driven by both our organic growth as well as the inclusion of acquisitions over the last 12 months.

As a percentage of sales SDMA was 16.9% compared to 17.1% in Q1 fiscal 19.

GAAP net income and EPS in the first quarter increased 157% and 119% year over year, respectively. The increase was driven by strong operating performance as well as a lower effective tax rate. This quarter as a result of discrete tax benefits associated with stock based compensation.

Adjusted net income for the first quarter increased 31.9% and adjusted EPS was 44 cents per share up 13% from 39 cents in Q1 last year.

Adjusted EBITDA for Q1 increased 16% year over year to 36.7 million exceeding our guidance of 32% to $34 million as a result of higher than expected revenue and gross margin.

Adjusted EBITDA margin was 20.7% above our guidance of approximately 20%.

Finally, free cash flow, which we defined as cash flow from operations less capital expenditures was 14.7 million compared with 16.3 million in Q1 fiscal 19.

Capital expenditures in Q1 were up by approximately 6 million from a year ago as we continue to invest in growing the business.

Slide nine presents Mercury's balance sheet for the last five quarters. The Q1 fiscal 20 balance sheet includes the PC acquisition.

Mercury ended Q1, Q1 fiscal 20 with cash and cash equivalents of 161.3 million, our cash balance was down 96.6 million from $257.9 million at the end of Q4.

This reflected the acquisition of APC as well as a 14.6 million use of cash related to the vesting of restricted stock awards. The decrease was partially offset by free cash flow generation in the business.

From a capital structure perspective, we remain well positioned with continued flexibility and good access to capital at the ended the quarter, we had zero debt and $161 million of cash on the balance sheet.

In addition, we have a $750 million unfunded revolver with attractive rates.

This provides us with significant financial capacity for future R&D in capital investments to drive organic growth as well as capacity to execute on our M&A pipeline.

Turning to cash flow on slide 10, operating cash flow for Q1 was 24.3 million up 21.4% from 20 million in Q1 fiscal 19.

Free cash flow for Q1 was 14.7 million or 40% of adjusted EBITDA. This compares to our annual target of 50% on a normalized basis.

As we discussed on last quarters earnings call Q1, free cash flow reflects payments of yearend bonuses as well as expansion capex.

Capex in Q1 was 9.6 million or 5.4% of revenue driven primarily by our west coast RF facilities consolidation and investment in Phoenix.

This compares with Capex of 3.7 million or 2.6% of sales in Q1 last year.

As we announced earlier this month, we expect our capital investment in the Phoenix expansion to be around 15 million in fiscal 20.

As a result, we now expect free cash flow to come in at approximately 40% of adjusted EBITDA for the year.

I'll now turn to our financial guidance, which includes APC.

Starting with Q2 guidance on Slide 11, you can see that we're forecasting revenue to be a 185 to 195 million.

Q2, GAAP net income is expected to be 13.9 to 15.4 million or 25 to 28 cents per share.

Adjusted EPS is expected to be 46 to 48 cents per share.

Finally, adjusted EBITDA is expected to be 38.5 to 40.5 million representing approximately 20.8% of revenue.

Turning to slide 12, our guidance for fiscal 20 reflects the outlook the Mark discussed highlighted by continued growth and profitability.

For the full fiscal year, we now expect revenue of $775 million to $790 million.

This guidance represents 18% to 21% growth from fiscal 19 and is an increase from our previous guidance.

We now expect organic growth of 11% to 12% for fiscal 20 up from the 10% we mentioned on last quarter's call.

Total GAAP net income on a consolidated basis for fiscal 20 is expected to be $72.9 million to $77.8 million or $1.32 to $1.41 per share.

Adjusted EPS is expected to be in the range of $2 in three cents to $2, an 11 cents per share an increase of 10% to 15% compared to fiscal 19 results.

Our guidance for adjusted EBITDA is 169.5 to 175.5 million or 21.9% to 22.2% of revenue.

As I mentioned this increased guidance includes approximately 2 million of operating expense associated with the expansion in Phoenix.

We expect Capex for fiscal 2000 to be approximately 6% to 7% of revenue, reflecting our integration activities ongoing investment in the business and the expansion in Phoenix associated with our trusted micro electronics strategy.

Turning to slide 13 in summary, Mercury's Q1 was another excellent quarter with great operating results across the board our organic growth was strong we had record revenue and backlog, we completed the acquisition of APC and our M&A pipeline continues to be robust as a result.

Well positioned to make substantial growth investments in the business, while still delivering another record performance in fiscal 2000.

With that we'll be happy to take your questions. Operator, you can proceed with Q and right now.

Thank you as a reminder to ask a question you need to press star one on your telephone.

Withdraw your question first the pelkey.

Please standby Lee compiled the Q and a roster.

And our first question comes from the line no Sheila Kahyaoglu from Jefferies. Sir you may begin.

Hi, Good afternoon. Thank you guys sat for the time corridor.

Mark in your prepared remarks, you mentioned the Alabama. When you are called out with Raytheon can you talk about that contract with LP is capturing means for you and just.

How the Mercury team is part of that contract.

Sure. So we're obviously very excited that that Raytheon one the program we've been working with them on a number of years them, we've actually invested quite significantly our own internal R&D in the program itself actually includes Mercury's most advanced processing capability. So.

We're thrilled to be a part of the team and the success that they've hot.

Clearly it was a clean sheet design I think that was a large part of the when I think we contributed from a technology perspective to put it in context for Mercury, we actually think it's potentially the largest single program that we've won in our history.

Is there any way that kind of size what it means in terms of a content value our lifetime program value for you.

Well, maybe the best way to thinking about that is the yes in the third quarter, we're expecting a large booking.

Round about $30 million.

Which equates to a portion of the 384 million that rate deal is going to get for the six write offs.

The there on the contract to deliver so if you kind of do the math, we've got significant content on the program and.

Listening to toll on the call he expects that conservatively.

$20 billion program for them upgrading rent about 250 systems that exclude.

The potential for forward deployed radar. So it's a very very large opportunity for mercury over time and our content on the program is significantly larger than what it was on the predecessor, which is the Patriots system. So we're pretty excited chiller awesome. Thank you and then maybe just one on the Capex, how we see.

Normalized into next year in if Mike you begin any color on the capacity utilization and how we should be thinking Madden.

Yes, Sheila share. So we don't guide Capex beyond this year as you know, but this year, we have expansion investment, we said, 6% to 7% of revenue and Capex associated with the Phoenix build out in some of the integrations, including the West Coast facility.

The the capacity utilization and what we're well we're building out in Phoenix for the micro electronics.

Strategy to Mark discussed I'll, let him discussion of that.

A little bit, yes, theres really two things bail in parallel to the first is that we're coming to the end of the.

Build out of our West coast already facility, where with basically can it consolidates.

Although RF locations into that one plant that sets us up for continued growth in RF and we're seeing some nice opportunities that so we feel pretty good about the facility that we're building the way to think about the investment in the trust of micro electronics facility in Phoenix is basically a bad.

Being able to build the the capability set so we're actually expanding the scope as the sorts of trusted devices that we can manufacture that and so we're obviously in the early phases of building a thought that clean room as well as the manufacturing equipment, but we do think that that's a.

Substantial opportunity for us in the longer term.

Thank you for the color.

Okay. Thanks.

And our next question will come from.

Suzman from JP Morgan you may begin.

Thanks, very much and.

Good afternoon that nice quarter.

Maybe if you guys could talk a little bit about the gross margin in the quarter, it's kind of in the in the range of what we've seen.

For the past year, but maybe a little stronger at least than.

That I had been expecting coming in and some of the mix.

Wins or Tailwinds, you faced and kind of how to think about.

No, we're where we go from here in terms of the cadence.

Sure so as Mike.

So for the quarter, we did over achieved the gross margin we had guided around 43.5% came in a little higher than that.

We don't talk profit by program, but it really was just.

Program and product mix during the during the quarter so going forward as we as we look and you look at the annual guidance.

We we think that the gross margins are going to be similar to what we guided last quarter little bit higher but no fundamental changes in the business. Overall I think we also benefited a little bit set from some of the integration activities that we have underway with.

The integrations of tennis and the Jermaine.

Okay great.

And then anything.

To be aware of in terms of the direction.

The Pentagon Stan.

Fairly high profile recently about acquisition reform changes that there that they're making.

Any way in which you guys see that this FX mercury.

Yes, so clearly we're seeing more usage.

Hey, though for an OTA days.

The L. Tom's Award was no Ta contract I think what they're looking to do is to be able to develop new technologies more quickly.

And deploy them more more rapidly as well and then also get industry to participate in the funding associated with that so the use of owed Ta days on in particular, the use of non traditional defense contractors plays very nicely with kind of off position in the.

Industry is.

Business that spending anywhere between 11% to 13% of its revenue on advanced R&D capabilities and are able to do things more quickly and more affordably, which is one of the major reasons that more work is being outsourced. So we think the contracting reform actually.

Benefits Mercury as we saw in the L. Tom's Award.

Great. Thank you very much.

And our next question comes from the line of Pete Skibitski.

From lending global you may begin.

Good evening, guys nice quarter.

Hey, guys in the past under continuing resolutions I think Mercury's revenue has been a little bit inconsistent.

Hi, guys for the second quarter, you should have a CR for for virtually the entire quarter. So I'm feeling for some reason because of backlog, maybe you're just because of the stage of the cycle. We're in that the at this time to see our will have less of an impact on Q1 fiscal 20 or are you still a little bit concerned in terms of how long it could last just wants.

Color on that.

Sure. So given the strength of the current backlog, we actually don't expect any major impart to off 2020 financial outlook based upon the all opposites described today.

Which ends on November 21st.

Yes, we're assuming that the actual CR itself could lost.

Six months, so less and we don't believe is material risk.

To our guidance and our ability to deliver the numbers that we've just outlined.

Obviously as the year progresses, and we get better visibility.

As to what happens with the defense Appropriations Bill Yeah, we'll update our guidance, but for now we feel pretty good about opposition pace.

Okay sounds good and then Mark can you talk a little more about bill commonly in electronic warfare.

But it's obviously kind of a big push I think in terms of the pure threat.

Right now in DMD and you've got a strategic higher can you talk maybe about how R&D efforts might change with bill coming on board and I know he's got a lot of ideas I read about.

Just would love for you to kind of expand on what that could lead us to mercury, yes. So I mean built obviously, a very well know guy interested in the industry. He was pretty excited comps of mercury given the business model.

Yes, Hi described that were really the into section of the development of the commercial development of high technology.

For the use inside of the video D and so builds background or Lowi Ron.

He w. strategy for the last four years has touched in a whole host of other areas, including microelectronic strategy.

Okay and various other initiatives.

Yes, we're obviously participating in many of those areas in various ways and so he was pretty excited to be able to join the hi Tech commercial company that is operating in.

Inside of the defense industry, and and bring his knowledge to bear.

We don't think that it changes our business model, our investment levels or really focused right now.

I think he's got a pretty good perspective on what we're focused on and believes that we're investing in the right areas.

Great. Thanks for the color.

Right. Thanks paid.

Thank you and our next question will come from the line Jon Raviv from City you may begin.

Hey, Thanks, good afternoon.

On the silicon effort clearly you've made a decision here to to make to make a sizable investments to expand that capability set so what's your view on the profitability and return it thats sort of business.

They are there any does how did that impact the target range, the 20% to 26%. Thank you.

Yes, so we haven't been.

Yes, very specific John other than to say that the current.

Microelectronics business that we have that we acquired as part of the.

Microsemi Carbout acquisition back in 2016 has more than doubled in size and we've been able to increase the the level of profitability in that business over the last three years.

And the custom microelectronics business that we currently own is actually the most profitable product line that we haven't side of the company. So it's a nice area, we see the potential of significantly innovating in this space.

We do think it has the potential of continue to provide profitable organic growth over the longer term.

But I would add John that it is in the preliminary phase is and if you look at fiscal 2000 ages to highlighted I mentioned in my prepared remarks.

We don't have any revenue associated with this effort in F by 20.

And we do have 2 million of Opex. So that's in our guidance take a look at that but as Mark said the profitability should be nice as it ramps up but it's not a near term item.

Great. Thank you and then on the organic revenue growth long term Big picture can you just clarify I think on your prepared remarks, you said double digit organic revenue growth over the longer term I.

I think historically talked about high single low double.

Sorry, good Nit pick in any change there or or should we take this has.

Double digit organic grower going forward, yes. So we think we've averaged on average over the last.

Five years temps that organic growth so whether its high single digit low double digit all on our on average over time double digits, we feel good about those numbers.

Yes, I think we're seeing a tremendous amount of opportunity based upon the markets in which we're participating which appear to be areas. The DMD is focusing in on so we feel pretty good about potential.

To keep that high level of organic growth going Joan.

Thanks Mark.

And our next question will come from the line Ronald Epstein from Bank of America, you may begin.

Good afternoon, guys its kristine liwag dialing in for Ron.

Mark You mentioned this 15 million dollar capital investment a few times and it sounds like it's a very profitable business line can you expand more on.

What you're providing that the market currently does not have here to make it still profitable for you and also what specific capabilities are you building out and how critical vertically integrated will you be.

Yeah. So our goal is that we're seeking to create secure and trusted chip scale open architecture. So basically defense applications using the best commercially available silicon that's it.

That is being developed in the high Tech World. So we're not necessarily doing the basic design, but we're taking chip blitz from other companies on to basically do the engineering design.

And then and manufacturing of those devices, specifically for defense applications.

Helpful. And then if you're taking these designs from other companies what how do you assure that the company that you're acquiring from don't have suppliers that come from Unsecure suppliers like Chinese suppliers for example.

Because we're actually getting access to the best Silicon.

And the companies that we are teaming with.

Yes, hi, trusted processes in place and we're doing the packaging as those trusted devices here domestically in DMD a certified facilities.

I see and when you think about.

When you finish with this capex and you've already invested this money.

Do you have programs have you have already won the fillon capacity for this plant will or will you have to win new business in order to fill this capacity.

So clearly the initial stages, what we're doing as we are focusing on building out the clean room will be qualifying the manufacturing processes and in parallel we're actually designing the prototype devices that are targeting the initial application, which I won't go into.

And we're already in discussions with multiple customers on the initial application so.

Early days, obviously, we're going to need to to get the initial devices working and.

In the elrick doesn't begin until Mike as Mike said in his prepared remarks until our fiscal years 20, 122. So we got plenty capacity to begin with and you know we're investing in the business for future growth per se.

Thank you very much.

Thank you.

I will come from line of Peter Arment from Baird you may begin.

Thanks, Good evening Mark Mike.

Mark when you put up 17% organic growth this quarter and obviously double digit plan for the year up you are you able to quantify.

Kind of what you're picking up from the growth incremental growth from outsourcing just given the contact structure that was.

And on Lpms in some of the other aspects of it just seems like you're really well position that you're able to quantify that.

Not quantified specifically paid at but yeah I can tell you that we're seeing increased levels of outsourcing really across the board.

Yeah, I think I've talked about winning.

You know rate all enterprise processing architecture last quarter.

Yeah that was mentioned one of our customers calls.

In the last.

Over the last week or so.

The last time around they did the work in house on L. times, we've picked up more content that was previously done in house. So you know the outsourcing trend is clearly alive and well and given the level of investment that we're making.

On the shift to secure and trusted processing architectures were exceptionally well positioned Peter.

Yes.

Mike just on the adjusted EBITDA margin for this quarter 20.7.

20.8 for for the next quarters through the year when you implies your guidance here.

You're going to happen to have a much stronger second half.

So.

Is that just driven by mix you seem to benefit the synergies maybe just some color there. Thanks.

Yes.

Right at the highest level if you look at the midpoint of our guidance for Q2 is 20.8% midpoint for the year is 22%.

So we are expecting on an EBITDA basis, the second half two to be stronger.

The combination of slightly higher gross margins, but then also we're on the flip side.

Investing in the business as as I mentioned in my prepared remarks. So yes. The second half is looking to be better from.

Adjusted EBITDA margin perspective, because of that we also said pizza that we expected that the year to from a revenue perspective was slightly more backend weighted in the second half than the first so we got extra.

Volume that in H. too.

Sure the color nice quarter guys. Okay. Thanks beta.

Thank you.

And our next question will come from line, Michael Ciarmoli from Suntrust You may begin.

Hey, good evening guys. Thanks for taking the questions nice quarter.

Mark just to go back on the continuing resolution no impact.

On the fiscal 20 revenue plan, what do you think does anything change here in the near term on the bookings side of the equation. I mean, you guys have had a string of.

Very strong bookings quarters from India, if we do operate on a CR for the next three to six month, you see a scenario where bookings might slowdown.

We don't actually no we feel pretty good about bookings potential pipeline looks very strong Mike in.

We're expecting a continued positive book to Bill.

Got it and then on I'm, just going back to to Christine's question on the on the build out in Phoenix I mean have you guys already secured.

Design wins for these initial devices that you're working on that don't go into our control 20 122.

So will the devices don't exist right yet so we got to go do the design as well as the actual.

Prototype them and get through the build out of the manufacturing facility, but we have hard with a couple about teammates yeah pretty detailed discussions around what it is that we're trying to do in the very specific applications at these devices a targeted for.

Sure.

This is a very high level of interest so although we haven't technically got Oh, a design win the way in which we would.

Score that.

This significant interest out there Mike.

Got it and R&D, presumably going to be all digital systems on unsecured chips is that what we're we're kind of referencing here. So it's a mixed signal devices that include.

Security IP and obviously, we have invested heavily.

In embedded security and we've we've got a tremendous amount of intellectual property that.

Not combined with our ability to do trusted manufacturing as well as system level design that chip scale.

With the clearances that we have in the trust in the clear facilities.

Really puts mercury in a very unique position.

Can you give us a hint without maybe just general broad strokes, which end market. I mean is this more electronic warfare does it have to do with any of the emerging hypersonic opportunities out there. So.

Yeah, I think the application.

It is obviously going to evolve over time, but it's targeted it with the markets in which we're currently participating so radar E.W. missiles and munitions.

This is the the capability set as it evolves will allow new applications such as AI machine.

Machine learning and autonomy.

If edge processing applications and.

I won't go too much further than that.

Got it and then just last one you mentioned a couple of times I think working capital efficiencies what should we specifically look for as you guys start to undertake more of those actions I mean should we see no improvement in inventory to or what specifically should we should we pay attention to on that front.

Yes. So if you look at all working capital we're already starting to see some of those efficiencies. So yeah working capital as a percentage of revenue was down three points over three points year over year. So we build out the manufacturing facilities. We're obviously in the in a multiyear journey to know trying to imply.

Through the asset utilization the efficiency.

From a working capital over time, it but it does take time, we are starting to see some benefits.

Got it thanks, guys I'll turn back MCU alright, Thanks, Mike.

And our next question will come from line, Jonathan Ho from William Blair You may begin.

Good afternoon, and congrats on the strong results.

As you add more capabilities and broaden the portfolio are you seeing the primes come to your more often and basically or you're participating in nearly sort of every program design opportunity going forward.

So.

I think were viewed Jonathan really as a trusted partner and we really lean day in and invested heavily in.

R&D, particularly in the secure and trusted processing domain and one of the biggest trends that we see is that is these new architectures are compute ore processing architectures.

Whether it be fussy fly applications.

Or whether it be sensor and effective mission systems processing.

That shifted to secure and trusted systems is something that we're seeing a lot of opportunity around and nice I truly believe that we're a leader in this space. So that so yes, I think we're getting pulled into a lot of opportunities Jonathan.

Got it and then just relative to the faster or accelerated development cycles does that then help widen the gap in terms of your capabilities relative to competitors and can you maybe help us understand a little bit better why you're able to do this.

Faster and better than than others, yes. So look I think it's a great question. So if you look it.

Yeltsin's as an example, raytheon.

Took a different approach I think they took a clean sheet of paper design.

For the L. Tom's rate, all and wanted to demonstrate to the army. The Hot next generation technology, not just on the into gone level, where they've invested heavily.

For quite some time, but in other parts of the system, obviously in which Mercury participated so they fielded a very advanced rate off.

And they invested in we invested in not Oh, you know they were able to develop into demonstrate that those capabilities.

At the sense, often the radar performed extremely well so the fact that we're willing to fund high levels of R&D. We can do things quickly. We can do things more affordably than our customers are able to do it in house all plays into the use of eight to four and an OTA case.

Thank you.

Thank you and our next question comes on line of Noah Poponak from Goldman Sachs You may begin.

Hello, everyone.

Hi, Noah.

Hey, Mike on just on the organic growth calculation itself for the quarter. You. Obviously you have the one to actual and the one to 19 actual and then you gave us the 19 million of revenue from everything acquired over the last one year, if I strip that 19 out of the one Q.

I get 10% not 17%.

And did maybe it may be coincidental, but if I leave the partial.

Germain Q1 20, but take it entirely out of the year ago back does get me to the 17 is that the cow curve or what am I missing.

Yes, I know the the calculation is.

We consider something organic ones has been part of Mercury for for four quarters or more.

At that point it gets rolled in to the organic calculation.

And so this quarter still in acquired would have been.

Germain gecko, Athena syntactic and very very small amount of APC, which we own for for just a couple of days.

But once that is once they are with us for four more for four quarters or more than they are considered organic so.

I can walk you through the the actual calculation.

Later, if you want but thats the fundamental calculation window business in the back of the the press release in the tables, Yeah, we actually show.

Yeah, the calculation Noah period to period ends here when we do that period to period wants it flips from the acquired two organic we obviously restate prior period. So you can truly get an apples to apples comparison.

What are your restating.

The prior period, where it was previously organic.

Oh, I say I say.

Okay.

Got it.

The the backlog in the bookings behind that that revenue growth of have obviously been moving along pretty quickly here.

You mentioned earlier, some things that May go in it and the middle of this year.

Yes, if you.

I have any thoughts for us on where backlog or bookings growth could end the year for you.

Yeah, we don't actually guys either backlog or bookings, but we do expect to positive book to Bill.

Okay, Mike last one just on the cash flow.

You know you've got the elevated capex for the year and you had it in the quarter if I, if I kind of just cut that in half to two and half for 3%.

Revenue you would've had over that 50% conversion of of the free cash into EBITDA, but you also had a pretty sizable working capital headwind in the quarter. So I guess.

How do how did you do that or what else was there something else, helping you that we should be expecting to reverse or or what's behind that.

No I mean first of all I think your math in terms of the target for the year. If we had been at normalized capex might it have been above 50% I.

I think the answer there is yes, it could have been.

When we talked last quarter on last earnings call. We said that we were expecting capex to be about 5% of revenue. So that did include some expansion capex.

But that we were still targeting 50% of free cash flow to adjusted EBITDA. So if capex had been lower than that 5%. We would have had the opportunity to to overachieve now with the additional capex associated with.

The trusted microelectronics strategy of 15 million that now we're targeting 40% for the year.

From a working capital perspective for you get to remember Q1.

We have bonus payments and you see some of the items there that.

Make working capital little bit more of use cash in Q1, but otherwise working capital as a percentage of sales is looking good and for the year, we feel good about where we stand from a cash flow perspective. In Q1 also no. We actually have completed the acquisition of APC, which brought the inventory.

Although we only own them.

A week or so in the first quarter. So we got the benefit to the impact on the balance sheet, but not really the income statement, yes, it's important point and making sure you're looking at the.

The cash or use of working capital around the balance sheet.

Right I think thats squares Yep yep okay.

Okay. Thanks very much.

All right now thank you.

Thank you and we have a follow up from Pete Skibitski from Olympic Global you may begin.

Hey, guys. It looks like you guys got active in the quarter on the repurchases I guess coincident with the shares coming in is this something we can expect to see more consistently going forward. If the shares kind of lag here at this level.

Yeah. So just to clarify the dynamic on that we do not have a share repurchase program in place.

What that was in Q1, a lot of our restricted stock vesting Q1.

And to settle with the the tax payments associated with that we net settle the shares and Thats a use of cash for us and Thats. What you see there it's not a capital allocation strategy.

Okay got it.

Last one maybe more for Mark Mark you had mentioned a while back that you guys had been approved.

To make radiation hardened electronics by summer Oems I think for Leo satellites and beauty has this new space architecture that thats kind of evolving pretty fast it looks like I think that emphasizes smaller satellites.

And then of course, we are the commercial side. That's out there were a lot of big plans can you talk about kind of maybe the size of that business for you guys right now, but sort of you know how big it can give mid mid term the opportunities there yeah. So it's small today piece you know we're not a a major participant in that although the name.

Yeah, Rob tolerant storage devices.

If a leo applications and adopt part of our business is small, but it's actually growing quite rapidly.

And we Havent now the design win actually in the first quarter.

For a classified applications. So yeah. It's small yeah, we're not really participating in space too much other than those areas, but it's something that we'd like to.

Longer term and made maybe it's an opportunity for M&A.

Great. Thanks, so much alright.

And we have a follow up from John are you from city you may begin.

Hey, Thanks, Thanks, guys and I just on the free cash conversion now down to 40%. This year fully understood I was there a reasonable pass back to 50 in the near term or how long do you think it will take to get back there you mentioned a multiyear process for the build out.

So so we're only guiding you know for the year John .

In terms of what we see you know the expansion.

Yeah, Capex is largely associated as Mike said with the build out of the new capabilities in Phoenix as well as our integration activities. So we'll have more to say about what we expect in terms of future Capex and normalization in free cash flow as we guide in the out years.

John I would I would just add when we put the 50% free cash flow to adjusted EBITDA target in place that you know that is a long term goal based on.

Maintenance capex levels.

Thank you.

And we have a follow up Noah Poponak from Goldman Sachs, maybe again.

Mike You mentioned pretty pretty originally in the prepared remarks that the M&A pipeline looks.

Robust maybe you could just expand on.

Where it is compared to 36 months ago, just how robust.

I'd be surprised if you didn't have another deal by the end of year.

Yeah, I mean, the M&A market continues to be very active in our pipeline of acquisitions.

At that fit with us and our strategy is very strong right now so there's a there's a lot of activity Thats why we did the equity offering early in the year. So we could deploy that capital on M&A, we're seeing a lot of the proprietary deals that we've looked at over the last couple of years those are becoming actionable we're seeing significant.

Deal flow.

Coming to auction APC is a good example of that so a lot of activity out there we continue to be disciplined in our approach to M&A, but it is our number one capital deployment or use of cash and so we expect to continue to be active on the M&A front.

Alright, thank you.

Mr. Halfway appears there are no further questions if I would like to turn the call back over to you for any closing remarks.

Okay, well. Thank you very much for listening we look forward to speaking to you again next quarter.

Thank you.